A Bankruptcy Primer
Bankruptcy affords you the chance to get rid of creditors and old debts and get a start fresh.
For many people, there comes a point where they just want to raise
the white flag over their money ship and surrender. They do not want to write any more letters or explain their situation to any more nasty creditors or answer their phone anymore, not even once. Their ship is sinking.
After Richard lost his job, he had no way to take care of his family, other than using his credit cards more than he wanted. He lived off his credit cards for over a year. Once he started working again (making less than he had previously) he diligently tried to repay the $40,000 in new debt he had incurred, but fell farther and farther behind.
Richard has few options left. With debt amounts like these, no amount of fancy letter writing or negotiating is going to get him off the hook. Eventually, his creditors will sue him, win, and begin to attach his property. Once a creditor gets a judgment against a debtor, wages can be attached and applied to the amount due (a wage garnishment); bank accounts can be attached (a levy); homes can be attached (a lien); and property can be seized (a seizure). For many people, it is divorce, uninsured medical expenses, the loss of a job, the threat of a lawsuit, or a possible wage garnishment that finally forces them to seriously consider the bankruptcy option, although far less dire circumstances can also certainly precipitate a bankruptcy. You do not have to be drowning in debt to accept the protection a bankruptcy filing affords; you merely have to be at a place where you feel you need a fresh start. Your total indebtedness could be $5,000 or $500,000-it is strictly a personal decision based upon individual circumstances (although consider that a small amount like $5,000 could be paid back and the discharge saved for a rainier day).
Frank and Rose worked hard all their lives. As the years went by, their debts increased substantially, but they prided themselves on the fact that they always kept up with the payments. Their indebtedness was around $20,000, and they spent about $600 a month servicing that debt. Unfortunately, Rose became ill and was forced to retire. All of a sudden, bankruptcy became a viable option.
Whatever the reason, bankruptcy is a safe harbor in the financial storm, a place that can stop all creditor harassment, completely wipe out debts, and allow for a fresh start. Bankruptcy can set you free and forgive your debt. If you are at a place where it is a viable option, then forgiveness is probably a welcome, and pretty rare, sight right about now.
Don't Feel Too Bad
Let's dispense with this up front: Of course you would rather pay your creditors back, if that were possible. But if you are reading this, then it may not be possible. And while you might feel bad for your creditors, it also might be helpful to know that most of them will be just fine.
Most Chapter 7 filings today result from an overaccumulation of credit card debt. The typical 20 percent interest payment that most debtors are stuck with normally results in the actual debt being paid several times over. Also, credit card issuers calculate these exorbitant interest rates, at least in part, based upon how much of the total credit they offer will likely go unpaid due to bankruptcy and defaults. One of the reasons you have been paying such a high interest rate for so long, then, is that you have been subsidizing other people's bankruptcies and defaults for many years. And in any case, your credit card companies will just have to get by without your monthly payment and will have to live with the tax write-off they will receive. That is one of the costs of capitalism. Do not fret. Your creditors will survive.
Understand too that bankruptcy is a statutory right that has been part of civilized societies for thousands of years. Corporations file for bankruptcy protection all the time. Like you, sometimes they need help. In the past few years, over one million Americans a year have sought bankruptcy protection. So feel bad if you must, but get over it. You are in good company. Yes, you should learn your lessons and not get in this mess again. But both bankruptcy and this country are about second chances. If you need to, take yours.
Bankruptcy: The Ultimate Trump Card
The whole point of bankruptcy is to give cash-strapped, scared, harried, overextended, well-intentioned debtors a chance to start over without any more creditor harassment. It does so in many ways.
The very first thing to happen that will make your life easier occurs the moment you file your bankruptcy paperwork, when the bankruptcy court issues an order, called the automatic stay. The stay is a federal court order that immediately puts a halt to all collection activities. It is not called an automatic stay for nothing-the stay is ordered immediately upon the filing of every bankruptcy.
The breadth of the stay is impressive indeed.
SDS Collection Bureau had been hounding Jill for several months. Finally, it filed suit against her in small claims court. The day before she was set to go to trial, Jill filed a Chapter 7 bankruptcy. The next day Jill showed up in court, showed the clerk her bankruptcy paperwork, and the trial was canceled.
The stay stops all collector actions dead in their tracks. It stops lawsuits. It stops wage garnishments. It stops all phone calls and letters. It stops auto repossessions. It even stops home foreclosures. Now, think about that for a minute. Your home could be on the block, ready to be sold at a foreclosure sale tomorrow, and if you file bankruptcy today, the sale will be stopped. No matter what action a collector is about to take against you, you hold the ultimate trump card: bankruptcy and the automatic stay.
The automatic stay remains in effect for the duration of the bankruptcy, usually about four months for a Chapter 7. At the end of the case, the debtor receives a discharge, another court order stating that the debts have been forgiven and the debtor is no longer liable for them.
Thus, for most people, the filing of the case and the corresponding issuance of the automatic stay means that they will never have to deal with most of their creditors again. The stay stops all communication during the course of the bankruptcy proceedings, and the discharge forgives the debts altogether.
Advantages and Disadvantages
The automatic stay is the first of many advantages that a bankruptcy filing affords a weary debtor. The other obvious benefit is that most, if not all, of your debts will be completely wiped out when the case ends and you receive your discharge. You could owe $80,000 to six different credit cards, and the entire debt will be forgiven at the conclusion of your case.
This in turn has another, tangential, benefit.
Wendy was having $200 of her paycheck garnished every month by one of her creditors. She then filed for Chapter 7 bankruptcy. The garnishment was released. On top of that, she no longer had to pay the other $600 that she had been paying on her other debts every month. All of a sudden, Wendy had an extra $800 a month that she did not have before filing.
For Wendy, filing bankruptcy was almost like getting a raise. The opportunity to get rid of $800 a month in payments freed up a lot of disposable income for her, money she could use for more essential needs.
One final advantage to filing bankruptcy is the peace of mind it creates for many people. Few problems cause more marital strife and personal stress than financial ones. Bankruptcy, with its chance to start anew and get creditors off your back, will help you get along better with your mate and enable you to sleep better at night.
Of course there are downsides to filing bankruptcy. These are the most notable:
- The effect on your credit report. Unlike other types of credit notations, which stay on your credit report for seven years, a bankruptcy stays on for ten years.
- The effect on future credit. Filing bankruptcy does not mean that you will never get credit again. It does mean that the credit you do get will be more expensive. Whereas you might be able to get a car loan at 10 percent today, that same loan will cost around 20 percent after you file. While people routinely get home loans about two years after their bankruptcy is concluded, they pay higher interest, and are charged more points, to get that loan. Credit cards will be secured rather than unsecured for the foreseeable future.
- Loss of property. In a small number of cases, a person may lose some of her property to the bankruptcy trustee. This only occurs when the person files her bankruptcy without assistance of counsel (called filing pro per) and does not know what she is doing, or has a bad attorney, or owns too much property.
- Stigma. While there used to be a great stigma about filing bankruptcy, that is far less true today. With so many people doing it, and so many notable businesses and celebrities doing it, for good or ill, there is not much social stigma left.
Although there are certainly some negative aspects to filing bankruptcy, the truth is, for most people who are at a point where they are seriously contemplating it, the benefits usually outweigh the burdens.
Types of Bankruptcies
There are four types of bankruptcies individuals may consider: Chapter 7, Chapter 11, Chapter 12, and Chapter 13 (these are chapters of the United States Bankruptcy Code). As already noted, Chapter 7 is by far the most common one used by consumers, and is usually the best choice. Chapter 11 is used by large businesses who want to reorganize their debts, and sometimes by very wealthy individuals. It is inappropriate to almost all consumer debtors. Chapter 12 is a type of bankruptcy specifically designed to help family farmers. Its use too is fairly rare. Like Chapter 11, Chapter 13 is also a type of reorganization of debt, but is intended for use by consumers. In a small number of cases, the use of a Chapter 13 makes sense. Almost all consumers or small businesses will file either a Chapter 7 or a Chapter 13 bankruptcy.
Which is Best for You?
You want to, and most likely will, file a Chapter 7 bankruptcy. A Chapter 13 is used only in very specific, limited circumstances. It is most often used to save a home that is about to be foreclosed upon.
Marla and Stuart were having a difficult time keeping up with their mortgage and bills. They were two months behind on their house payment when their lender started foreclosure proceedings. They consulted with an attorney and filed Chapter 13. By doing so, they were able to repay their past-due mortgage over a three-year period to the bankruptcy trustee, who, in turn, repaid their lender.
The heart of a Chapter 13 is a repayment plan that lasts anywhere from three to five years, depending on the circumstances. The debtor promises to pay a certain amount of money each month to the Chapter 13 trustee, who in turn pays back the debtor's creditors. Typically, secured debtors are repaid 100 percent, and unsecured creditors get back only a portion of what they are owed.
Besides making up home mortgage arrears, the only other time a Chapter 13 is normally used is when a debtor has non-exempt assets. Each state has a different set of rules, called exemptions, which are used to determine how much property a debtor can keep in a Chapter 7. Essentially, exemption means protection. If you are able to exempt property, that means you are able to protect it and keep it. Although the exemption rules in some states are generous, they are not limitless. If the value of your property is more than the exemption rules of your state allow, and you file a Chapter 7, the trustee in your case will take and sell whatever property you own that is over the limit. Another reason a Chapter 13 is used is to avoid that possibility.It took thirty years, but Shirley finally paid off her mortgage. Her home was worth $75,000. In her state, the exemption limit on home equity was $50,000. If Shirley filed a Chapter 7, her bankruptcy trustee would take her house, sell it, pay Shirley the $50,000 she was legally permitted to exempt, and use the other $25,000 to pay her creditors. If she filed a Chapter 13, Shirley could keep her home.
Another reason that a person may choose a Chapter 13 is that it allows for what is called a "super-discharge." Not all debts are discharged by a Chapter 7 bankruptcy; for example, debts induced by fraud. A Chapter 13 super-discharge allows for discharge of these sorts of debts whereas a Chapter 7 does not.
Normally, however, a Chapter 7 is almost always a better choice. It is much simpler than a Chapter 13-there is no plan and no ongoing payments to the trustee. It is quick-about four months from start to finish, as opposed to a minimum of three years for a Chapter 13 case. Chapter 7s cost less-legal fees are considerably lower in a Chapter 7 than in a Chapter 13. Best of all, it solves the problem-debtors normally pay nothing back to their creditors. The reason that a Chapter 7 makes sense for most consumer debtors is that they have a lot of unsecured debt-credit cards, medical bills, lines of credit, that sort of thing. Whereas a Chapter 13 forces a debtor to repay some of this money over a several-year period, a Chapter 7 completely avoids that. Not a penny is paid back to unsecured creditors in a Chapter 7.
It is also attractive because most states create exemption limits high enough to allow most debtors to keep all of their property. It is this chance to discharge all debts and keep all property that makes Chapter 7 so appealing. Taking into consideration its relatively short duration as well, a Chapter 7 is far more preferable than a Chapter 13.
If you have a lot of unsecured debt, or a mix of secured and unsecured, then Chapter 7 makes sense. If you are about to lose a home or car to a bank, or have a lot of non-exempt property, then a Chapter 13 is your best bet.
The Important Legal Concept to Remember:
Bankruptcy affords you the chance to get rid of creditors and old debts and get a start fresh. If at all possible, file a Chapter 7.
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